JEDDAH, 25 July 2007 — The Saudi stock market is heading for steady gains after suffering massive losses in 2006. The Tadawul All-Share Index (TASI) dropped by 52.53 percent to 7,933.29 points last year. The market capitalization also dropped 49.72 percent to SR1,225.86 billion ($326.9 billion) in 2006.
The TASI, however, gained 133.75 points or 1.8 percent to 7,570.42 yesterday with market turnover of around SR7.76 billion.
According to a report by the Riyadh-based Jadwa Investment released yesterday, the macroeconomic and stock market conditions are in place for steady gains in share prices on the Saudi stock market.
Brad Bourland, chief economist and head of research at Jadwa Investment, said: “At midyear 2007 the major downturn appears to be over. Many listed companies can reasonably be considered to be at fair value or undervalued. In particular, the 10 largest companies by market capitalization trade collectively at a price-to-earnings (P/E) ratio of 13; for the top 25 stocks, the P/E is 14. The remaining stocks trade at a collective P/E ratio of 34, which we view as overvalued.”
He added: “The positive macroeconomic backdrop means that profits growth is likely to average 10-15 percent per year, leading to a similar rate of increase for the stock index.”
The Jadwa Investment report said because the stock market index (TASI) is an all-share index weighted by market capitalization (meaning every stock in the market is part of the index and its weight in the index is determined by its capitalization), the stocks with large market capitalization mainly determine the movement of the index. As the large-cap stocks appear reasonably valued, the TASI is not likely to decline much further from the lows it recently established in the upper 6,000s.
Nonetheless, smaller stocks could still decline sharply because of their high valuations, though this would not be reflected in a similar move in the index.
The report said for investors, the Saudi market has become a “stock-pickers” market, meaning choose carefully, as many stocks are likely to continue sharp declines as others move up. As with the aftermath of other major sell-offs, the Saudi market to remain in a consolidation phase through 2010.
Bourland said: “Because of the strong macroeconomic fundamentals, however, we expect steady, if unspectacular, gains. Profit growth for listed companies should range from 10-15 percent per year, and that should be the gain expected for the index annually as well, as we expect the market to trade at a similar P/E ratio for some time. We would not be surprised to see the P/Es of large-cap stocks rise into the higher teens, or in market jargon, to experience “multiple expansion” in 2009 and 2010, as optimism about the economy continues to build and as the 2006 crash is put further behind us.”
He added: “An annual rise of 10 percent in the TASI from a present fair-value level of 7,500, would place the index at 9,980 at year-end 2010. An annul rise of 15 percent would put the TASI at 11,400 at end-2010. We think this range is a reasonable expectation to work from.”
How can investors profit in this market over the next 3 years?
The Jadwa Investment report said investors should focus on larger companies with reasonable valuations. They also should pay attention to objective research for “buy” recommendations. The days of everything moving up are over for the time being.
While large companies are currently more cheaply priced, there are some “hidden gems” among the smaller stocks on the market, with good profitability and strong competitive positions in fast-growing sectors of the economy.
The report also said there will not be a revaluation of the riyal. This favors companies that export, as the competitiveness of their products will not be harmed by the exchange rate. It also helps projects and companies that count on foreign spending and investment, such as travel and tourism, the economic cities, and petrochemical megaprojects.
The report added that, in general, inflation will subside. This should help share prices because high inflation reduces the price that investors will pay today for future company earnings. However, continued high growth in rents will put pressure on the profitability of companies that have high rental expenses.
While inflation at the consumer level will be contained, prices for goods at the corporate level (“wholesale” price inflation) will be higher, hurting some companies in sectors such as construction and building materials.
Continued economic reform means increased competition in some sectors. For example, high growth in financial services, the rapid opening of the market and influx of foreign players will inevitably erode the profitability of existing banks.